Tarzan update 1

This is fun. My new system on Collective2 is off to a fast start.

As I said before, swing trade systems don’t come naturally to me, so this was very challenging. The system holds 7 positions at a time with an average hold time in the neighborhood of 7 trading days, so it roughly turns over one position a day… which, in my opinion, qualifies as a modestly paced swing trade pattern.

However, the current return rate will not be sustained. In fact, I am confident that it is way out in front of its sustainable return rate, so much so that I felt compelled to add a warning at the front of the system overview. Here’s how the description currently reads.

WARNING: Please do not take the current C2-forecasted return rate as accurate… it is much too high. I expect the Tarzan to make between 40% and 100% per year, with perhaps a 70% average. The system happens to be off to a fast start since I signed up for C2, which is gratifying, but I do not expect to make 200% (or higher) a year in the long run. I say all this because I do not want negative reviews from subscribers who had inflated expectations for the system. Tarzan is designed to achieve excellent returns year after year. It is not a get rich quick scheme.

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Tarzan is intended to beat the market without consuming you as a trader or introducing extreme risk. Tarzan swings through the market, guiding you from trade to trade at a reasonable pace and with good success over time.

If you want a twitchy minute-by-minute system, there are probably many good (and even more bad) options on C2, but this is not one of them. However, you may well be interested in Tarzan if the following characteristics appeal to you.

1) Liquid stocks that provide solid fills

2) Both long and short positions

4) Positions generally held for 2 to 10 days (i.e. swing trades)

3) 7 trades active at a time

5) Orders entered while the market is closed to be filled the following open (this includes all orders: Buy to Open, Sell to Open, Sell to Close, Buy to Close) ~ yes, you can trade Tarzan while working a full time job

6) No leverage. You will use the margin in your account to allow you to close 1 position and open another one at the same time ~ obviously, this is up to you, but our C2 results are achieved with no leverage

The net result of all of this is this: each evening, you will typically have one position to manage. You will enter a BTC or STC against an existing position and enter a new BTO or STO, with both the entry and exit order set to execute at the next market open. Automated trading is also supported.

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All entry and exit signals are generated by a proprietary trading system that enters with the trend after a correction and exits either when the correction shows itself to be the new trend or when the correction has itself been corrected.

The backtest results include 79 12-month returns (sampled at the beginning of each successive month). Of those 79 12-month periods, the following results apply:

12-month return ==== Percent of 79 samples above the return rate
0% or more ==== 100%
15% or more ==== 98.7%
25% or more ==== 91.1%
50% or more ==== 78.5%

Now, lets break it down the same way, but using the 6-month profit (there are therefore 6 extra samples, or 85 total periods).

6-month return ==== Percent of 85 samples above the return rate
-10% or more ==== 100%
0% or more ==== 91.8%
10% or more ==== 80%
20% or more ==== 67%

The compound annual return over that entire period was 82%. During that same period, the worst drawdown experienced was 31%. To be honest, I never expect the future to perform as well as the past due to such pitfalls as backfitting the data (hopefully a very minimal problem… I certainly worked hard to avoid this one), the gradual change in trader psychology over time, etc. My expectation is that the CAR will be in the neighborhood of 70%. I will continue to seek improvements in the system, but generally my focus will be on lowering that drawdown, which is high for my liking (I am targetting a 20% max DD), and not to increase the CAR.

What is the takeaway? Like any good system, results do fine in the long run (6 months or more in most years). But dipping in and out of this system (and others) can potentially minimize the profit potential.

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Frequently Asked Questions

What is the recommended account size?
The return rate is rather important in this calculation, so lets assume 43% a year (see backtest results above). That works out to a compounded 3% a month. So an account with $2500 would make $75 a month, just enough to pay for the system. Now I hope to do a lot better than 43% most years, but is provides a conservative estimate, and would indicate an account would need to be in the $5000 (or more) to make the monthly fee worthwhile (i.e. the remaining return is sufficient to beat the market). A higher return rate would obviously allow for a smaller account being successful. Likewise, a larger account increases the effective return rate (once the $75 is deducted).

Where are the stops?
As 1) Tarzan is a mechanical system and 2) a loss stop cannot be proven to be of any value in the past 8 years… there are none. I like stops. I have worked hard to find a way to use them effectively with Tarzan, but it just does not work. Instead, I review each position each evening in accordance with strict exit rules for the system and exit losing positions the following morning. However, I understand that some traders will want to add a discretionary intraday stop, and that is fine, just please make it as large as you possibly can within your comfort zone. A close stop, even a seemingly large stop, will hurt performance over time. A loss stop will definitely help you on some trades, but it will bleed you dry over the long haul if the data is to be trusted. So add a stop if you would like, but keep it very far from the purchase price (like greater than 20%). My own approach is to use conservative money management in place of a stop, so that even in the worst case of a, say, 40% loss on a position, I would still do okay in the long run because I had not plowed my whole account into that trade. That backtested resuslts (with that 30% drawdown and 80% CAR) use no stops and put 1/7 of the account into each position.

3 Comments

  1. Rusty Burlingame
    Sep 26, 2007

    After being walloped by the Tech Bubble, I read “A Random Walk Down Wall Street” and we’ve been plowing our savings into Vanguard funds ever since.
    I’m feeling a bit of cognitive dissonance. You’re a very wise man, so I’m interested in how you explain this. Are you taking extraordinary risk? Betting that things will return to the mean, like LTCM? Have you ever read Random Walk, and what do you make of that?
    Rusty

  2. Jay
    Sep 27, 2007

    Hey Rusty! I think I may have mentioned this before on the blog, but I think Vanguard funds are a great idea. The rise of ETFs also looks like a good approach, though I haven’t looked into them much.

    I have Random Walk but haven’t gotten to it yet (working through the Harry Potter books right now). However, I do not believe efficient market theories give a good account of the short term (I am not opinionated on the long term as I haven’t investigated it). Issues of liquidity as the big guys enter/exit an equity, overall investor psychology, etc. do not make for an efficient market in the 1 to 5 day time frame. Take a look at “Extraordinary Popular Delusions and the Madness of Crowds” (originally published in 1841 but I believe very applicable today) and ask yourself if a Random Walk theory explains these sorts of events. I believe such madness takes place every day in the stock market on individual equities in the very short term.

    Am I taking extraordinary risk? No (or, more accurately, I don’t believe so after a couple thousand hours of working on it). If investing in the S&P 500 is an ordinary risk (which in the past 10 years includes a drawdown on the order of 50%), I am taking very ordinary risk. Perhaps it is extraordinary risk, but on the favorable side. I would never trade a system that showed in 50% drawdown in the past 10 years.

    I’ve had several questions on my actual approach, so I’ll try to post something on that in the coming days.

  3. Rusty Burlingame
    Sep 29, 2007

    Hi Jay –
    The Vanguard funds have worked out well for me. Besides capturing the market return, they’ve had the other benefits of requiring absolutely none of my time, and I sleep a little better at night.
    Regarding efficient markets, I think it depends on what you’re investing in. Are you looking at very small companies with a relatively small number of transactions? I might be convinced. If you’re trading GE and Microsoft, or more generally stocks in the S&P 500, I’m less inclined to agree. With millions of shares traded per day, that’s an efficient market. The people trading GE (as a whole) know a lot more about GE than I do.
    If you actually generate the returns you’re expecting trading stocks in the S&P 500, that is an amazing feat.
    Two other comments, if you will. I think it’s one thing to be able to say, “We’re in a tech bubble” or “These tulips cost way too much.” But it’s really hard to invest against a bubble. Greenspan was warning of irrational exuberance a couple of years before the bubble popped. Shorting too early would have cost quite a lot, not to mention passing up the rest of the ride up.
    Besides that, I can’t think of how you’d try to exploit popularity in the 1-5 day time frame. That’s mindblowing to me, and I’d love to hear more about that. Are you researching these companies, or is your selection based on some kind of technical analysis or trend detection? I’m intensely curious.
    Finally, the big question for me. Why aren’t others discovering this, and competing away the returns? Why isn’t some mutual fund company advertising a fund that returned 70% on average over the past 6 years?
    Greatly enjoying this,
    Rusty